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Bear of the Day: Innovative Industrial Properties (IIPR)

·4 min read

Innovative Industrial Properties (IIPR) has gained almost 150% over the past two years – in addition to paying steadily increasing quarterly dividends. While the rest of the industry was reeling, IIPR was quietly acquiring new properties and increasing its market cap.

IIPR engages in one core business practice – buying real estate properties that are used for cannabis business activities (primarily cultivation), provides tenant improvements to make those properties more suitable for the intended business activities and then leases them back to the previous owners on very attractive terms.

The sale-leaseback arrangement is not uncommon in the commercial real estate world – many other Real Estate Investment Trusts do essentially the same thing – but IIPR was the only large scale REIT to specialize in cannabis properties. That, combined with the fact that cannabis companies in the US have been almost entirely shut out of traditional borrowing/lending activity is what allows IIPR to sign leases with 15-year terms and charge 15% of their total investment annually on a triple-net basis in rent.

IIPR is essentially lending millions of dollars to cannabis companies who don’t have access to other sources of capital and collecting a commensurately high interest rate for doing so. They raise cash in the equity markets (that’s us), and structure real estate deals that provide that cash to cannabis businesses for growth initiatives, capital purchases, etc.

It’s a very clever - and totally legal - end-run around regulations that prevent federally insured lending institutions from doing business with companies engaged in a business that’s still illegal at the federal level.

Recently, the Chairman of the House Judiciary Committee, Jerry Nadler (D, NY) announced that he would be reintroducing the Mariuana Opportunity Reinvestment and Expungement (MORE) Act. That legislation would broadly legalize cannabis, expunge prior convictions and establish a national tax structure. It was easily approved in the House last year, but was never even discussed in the Senate because of the objections of former Majority leader Mitch McConnell (R, KY).

With the current 50/50 splint in the Senate and the tie-breaking vote belonging to Vice President Kamala Harris - who personally drafted some of the bill's language - the chances of the MORE Act passing are now pretty high.

That’s likely to cut into the juicy cap rates that IIPR has been enjoying. Prospective tenants won't have to do a leaseback deal with a landlord if they can get a mortgage and/or take out a conventional business loan from a bank.

Another political consideration is the latest fiscal stimulus involves nearly $2 trillion more in US Government borrowing. The debt markets have already been anticipating increased debt sales and interest rates on US Treasuries have been rising. So far, the effect has been fairly modest, but the direction in medium to long-term rates is undeniably upward.

If other debt instruments are trading at higher yields, the shares of REITs that have a portfolio of assets that provide fixed (or in this case - slightly rising) lease income will tend to look less attractive in comparison.  That could put pressure on IIPR share price in order for buyers to view the dividend as an attractive yield.

IIPR did a fantastic job raising capital in the equity markets and then putting it to use generating income for shareholders, but those good times can’t last forever. With US legalization looming, it’s increasingly less likely that they’ll be able to do nearly as well.

Those who owned IIPR over the past two years were rewarded with solid dividend income as well as huge capital appreciation. Going forward, it’s much more likely to yield and perform like an ordinary REIT.

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